SMSF Strategy

4 ways your SMSF can invest directly into property

With strong interest and growth currently occurring within the property market, I regularly get interest from clients about how they can invest in property using their self managed super fund.  The answer is never straight forward as a range of personal circumstances start to take over the conversation regarding the type of property, contribution levels, personal tax levels, capital growth and so on.  There are several ways in which you can consider using your self managed super fund to acquire (or have an interest) in direct property, whether it be residential or commercial.

1. Buy it straight out

This is the simplest way.  The asset would be held in the name of the fund trustee(s) in trust for the SMSF.  I would strongly recommend a corporate trustee here as the title is typically held in the name of the trustee and makes no reference to the underlying trust structure (i.e. the SMSF).

Advantages - Simple, concessional tax treatment on income and future capital gains (in particular in pension phase – tax free!!)

Disadvantages - requires a significant commitment of capital to acquire the asset; need to be conscious of ongoing liquidity requirements of the fund and its members (e.g. pension paying phase) as you can’t sell a brick at a time!!

2. Tenants in Common

An SMSF has the ability to co-invest with another investor, such as an individual, trust, another SMSF, etc.  The important thing to note here is that the property must be unencumbered, that is, no charge can be placed over the asset as security for any borrowings that another investor may require.

Advantages – Allows for other investors to participate when SMSF does not have sufficient capital; concessional tax treatment on part of the income and part of the future capital gains (in particular in pension phase – tax free!!).

Disadvantages - requires a significant commitment of capital to acquire the asset; need to be conscious of ongoing liquidity requirements of the fund and its members (e.g. pension paying phase) as you can’t sell a brick at a time!!

NB.  For business real property (commercial property), there is an ability in some states for related individuals & entities of the SMSF to transfer their interest into the SMSF without stamp duty.  Also, where the property is being used or has been used within your business, there is potential scope to eliminate the CGT by using the Small Business Concessions.

3. Unit Trust (geared/ungeared)

This is a more typical structure for an SMSF to co-invest with another investor.  The SMSF would subscribe for units in the unit trust (as would the other investor(s)).  There are several different and important rules to be aware of with unit trust arrangements.  These include:

–          If the trust was established before 11 August 1999, these ‘golden’ unit trust have a different set of rules to be applied to them.  Simply, the fund can borrow money and place a charge over the trust asset(s) without being classified as an in-house asset and be in breach of superannuation law requirements.

–          If the trust was established after 10 August 1999, these unit trusts must be ungeared (some exceptions – see below), with no charge to by placed over the assets of the SMSF.  Regardless of the investments within the trust (including residential property), there is scope to effectively transfer the ‘value’ of the external units across to the SMSF without breaching the in-house assets rules (SIS Act).  Stamp duty considerations still need to be considered on a case-by-case basis for unit trusts that are ‘land rich’, but a unit trust does have an advantage over tenants in common to bypass stamp duty for some transactions.  For business owners, using a ungeared unit trust arrangement has been a popular strategy as it permits a ‘recycling’ strategy for contributions into the fund and then for the fund to subscribe for units and the individual (or other entity) effectively redeeming existing holdings (and getting the cash back).  Again, Small Business Concessions can apply towards CGT issues on the transfer into the SMSF for business owners operating (or previously operating) from these premises.

–          As stated above, there are some exceptions for the ability for a current day unit trust to borrow and place a charge over the property.  Superannuation law in this regard looks at the level of control or influence one may have in determining whether the asset is an in-house asset.  That level of control does not just relate to a specific individual; a wide net is cast through a definition of Part 8 Associate which covers broadly family, relatives and companies where the member sufficiently influences of controls that entity.  Control exists where:

  • a group relating to that entity has a fixed entitlement to more than 50% of the capital or income of the trust;
  • The trustee of the trust/majority of the trustees is accustomed to, or is under an obligation to (either formal or informal), or might reasonably be expected to act in accordance with the directions of a group relating to that entity; or
  • A group relating to the entity is able to remove or appoint the trustee/majority of the trustees of the trust.

Therefore, where there is no control, the unit trust can invest in property, gear the trust and place a charge over the asset as security.  This is a common type of arrangement for professionals such as medical practitioners.

The use of a unit trust is also common for people who wish to develop.  Whilst not expressly prohibited for development, the ATO does not take a positive view in respect to fund’s acting like a business.  It is therefore common for SMSFs to invest in the trust and have the trust develop the land or existing property as the trust falls outside the superannuation legislation.  However, where the asset ultimately wants to move into the fund, consideration of CGT for example may become an issue.

Advantages – Allows for other investors to participate when SMSF does not have sufficient capital; concessional tax treatment on part of the income and part of the future capital gains (in particular in pension phase – tax free!!); potential saving of stamp duty on transfer of units into SMSF; SMSF can sell down units to other interested parties for liquidity purposes (i.e. you can sell a brick at a time!!)

Disadvantages – limited circumstances to ‘gear’ trust; additional trust structure which requires financial statements and tax returns (accounting fees); may still incur stamp duty if trust is land rich; need to maintain unit register for changes to holdings.

4. SMSF Instalment Warrant

The introduction of gearing in super has certainly sparked some serious interest of investors back into the property market.  With many people steering clear of direct property investment within an SMSF due to lack of diversification, the ability to now borrow using an instalment warrant arrangement allows SMSFs to invest in bricks and mortar but not carry the weight of future liquidity restrictions in investing in a lumpy asset.  With LVR’s between high 50’s% to mid 70’s% for commercial through to residential property, we are seeing people moving into SMSFs at an earlier age as they consider property investing as their way to meet their retirement goals.  With rental income and contributions to pay off the principal and interest repayments, it is a great way to accelerate repayments and get the benefits of concessional treatment inside super.

There are issues to consider around the non-recourse nature of the loan, cash flow requirements (including considering/revisiting your insurance requirements), etc.

You can read more on SMSF instalment warrant lending with property by clicking on my blogs –  Gearing in Super… a property revolution has begun and Shift your super into a higher gear.

Advantages – Allows for the SMSF to acquire the property (no other parties); two inflows for one repayment (accelerate wealth); in the event of default lender’s rights limited to property, therefore other SMSF assets are protected; future capital growth inside super (no CGT in pension phase); accumulators have long term retirement horizon to use gearing strategy.

Disadvantages – need to be able to service the repayments; may have restrictions of contribution caps to make repayments; need to understand risks inherent with gearing;

The ability to create property strategies inside an SMSF is certainly a challenging one to ensure that you get the best outcome for an individual both now and in the future.  With gearing in super and the strategies are starting to come with these, we may begin to see SMSF instalment warrants investing into ungeared unit trust arrangements to develop land?  Who knows? Strategies are limited only by the imagination of those who know how to apply the law…

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